Select Committee on Environmental Audit Minutes of Evidence

Memorandum from the Combined Heat and Power Association (CHPA)


  The Association welcomes the opportunity to make an additional submission to the Environmental Audit Committee inquiry into sustainable energy.

  The Association submitted its original memorandum to the Environmental Audit Committee in January 2001. This supplementary note updates the Committee on developments since then.[1]


  All the major developers of CHP have withdrawn from the market or put their development work on hold in the period since NETA "Go-live" in March 2001.

  For instance, the UK's two largest developers of CHP projects, Innogy Cogen and Powergen CHP have announced their decision to cease the development of new CHP plant. Together these companies have developed approximately 25 per cent of the UK's present CHP capacity. Powergen's decision follows a period of 10 months during which the company were actively seeking a buyer for their CHP business.


  The New Electricity Trading Arrangements (NETA) came into effect on 27 March 2001. The effects of this reform, driven by a joint committee of the DTI and OFGEM, have been dramatic upon many forms of sustainable generation, including CHP. This was widely predicted and communicated to Government by many organisations and companies in the two-year run-up to NETA.

  Ironically, in commissioning the programme of reforms, the Government asked the Energy Regulator to be sure that when the new trading arrangements came into effect they would provide:

    ". . . encouragement for Combined Heat and Power and renewables generators."

  Source: DTI Press Release, 8 October 1998.

  At the time of NETA "Go-live", in response to concerns raised by the sustainable energy community over the impact of NETA immediately following its introduction, the Government asked OFGEM to undertake a review of the impact of the first two months of NETA upon small generators.

  This report found that power exports from CHP had fallen by 61 per cent under NETA. It also reported that prices paid for power exports had fallen by 13 per cent, but noted that this may not be a fair representation since most of these contracts would have been negotiated before NETA went live. This suggests a fall in revenue to CHP plant of some £140 million in its first year.

  NETA has had the effect of increasing CO2 emissions by stimulating the use of conventional fossil-fuelled power plant. Recent media reports[2] suggest that NETA has driven changes in operating practices for conventional fossil-fuelled plant that will increase CO3 emissions by 270,000 tonnes/year.

  As experience of NETA grows, there is growing cause to question its validity as an economically efficient or fair means of operating the electricity network. A report submitted to the PIU[3], and considered by the DTI's "Consolidation Working Group", raised the following:

    —  the theoretical settlement costs imposed by NETA upon wind farms (and by implication other small generators) far exceed the actual cost to the National Grid Company of technically "balancing" the electricity system;

    —  OFGEM's "consolidation" option—may be effective in reducing the theoretical settlement costs for these generators. However, these costs continue to exceed the technical cost of balancing the system even with consolidation. Consolidation does not deliver an economically efficient solution; and

    —  the actual costs faced by wind generators (and other small generators) are exceeding even the theoretical settlement costs. The change in the commercial relationship between small generators and purchasers of power created by NETA, is a significant factor in depressing the prices now available to small generators.

  The Association remains concerned that a system of market operation that is not demonstrably based upon cost-reflective principles is discriminating against sustainable generators and directly undermining Government's climate change policy.

  None of this need have happened. The Ministerial commissioning letter asked the energy regulator to achieve an outcome that "encouraged" combined heat and power and renewables. This was not done.


  In the pre-budget report of November 1999, the Chancellor made an unequivocal statement regarding the treatment of CHP under the Climate Change Levy (CCL).

    "I have decided that renewable energy sources and combined heat and power will be exempt from the levy."

  Rt Hon Gordon Brown MP, Chancellor of the Exchequer, 9 November 1999 (Hansard col 883).

  The commitment to exempt CHP from the CCL remains to be fulfilled. At present the exemption is limited to exemption for power consumed on-site, and excludes power exports via a licensed supplier. This omission fails to recognise that the environmental benefits of CHP derive from the efficiency with which the power is generated and are not dependent upon the contractual "flow" of power or point of use. This exemption is vital in contributing towards commercial viability of CHP schemes, particularly in the present market circumstances.


  Sustainable generation is typically small scale and located in the distribution networks. The reform of the structure, operation and regulation of the power networks is essential if sustainable generation is to develop as a commercially viable, integrated generation technology. Without such reform sustainable generation will continue to be marginalized by the established physical and commercial structures of the industry, now reinforced by NETA.

  There is an apparent lack of urgency across Government in carrying forward the recommendations of its Embedded Generation Working Group (EGWG). To date OFGEM has issued only one substantive consultation—addressing interim arrangements for connection and use-of-system chares—and the EGWG's successor, the Distributed Generation Co-ordination Group, is only just getting underway. Compared to the resources OFGEM and the DTI committed to NETA, the scale of activity is presently inconsequential.


  DEFRA have been committed to producing a comprehensive CHP strategy since 1997. Despite repeated reassurances that a coherent, comprehensive CHP strategy setting out how the Government intends to achieve its 10 GWe target would be forthcoming, the Department has failed to produce such a document, let alone put in place clear legislative arrangements to underpin it. This policy vacuum creates uncertainty and difficulties for the industry, and is used by other parts of Government as an excuse for inaction.

  The DTI have estimated that every 1,000 MWe of CHP operating results in savings of 0.97 million tonnes of carbon per annum[4] through displacement of conventional, centralised power generation and independent boiler plant. Government has a target to achieve 10,000 MWe of CHP by 2010. With installed CHP capacity of 4,600 MWe in 2000, the growth in CHP to the 2010 target will deliver over five million tonnes of additional carbon savings. The need to produce an effective CHP strategy that will deliver these carbon savings is now critical.


  In general, planning authorities in the UK do not consider the development of the heat market in the context of their planning functions. This situation contrasts with the approach adopted towards other network utilities such as water, sewage, gas, electricity and telecoms.

  As the Royal Commission on Environmental Pollution has highlighted, the heat load development needs to be reinforced through the planning regime, as was highlighted in the Association's original submission. Placing such a requirement upon authorities would assist in identifying opportunities for the economic use of CHP linked to district energy networks.

  There has been little tangible development in this area, and the effectiveness of DTI's guidelines on "Exploration of the opportunities to use Combined Heat and Power, including community heating" when developing proposals for new power stations has been largely untested due to the downturn in development of all forms of new power plant since the advent of NETA.


  The DTI has, apparently inadvertently, included CHP in the "Renewables Obligation Base"—the volume of electricity upon which electricity suppliers' liability for Renewables Obligation is based. Consequently CHP is treated in a manner identical to conventional power generation, with no recognition of the environmental benefits that it delivers.

  The net effect of these arrangements is to cause CHP operators to subsidise the achievement of the Government's renewables target. It will cost the industry some £100 million, despite the major contribution that CHP already makes to reducing UK CO2 emissions.

  The solution to this paradoxical situation is to use forthcoming energy legislation from either DTI or DEFRA to change the legislative framework. It is understood the Secretary of State for Trade and Industry has indicated she is prepared to consider this. However, a firm commitment to resolve the matter in forthcoming legislation is awaited.


  The Government has taken the powers under the 2000 Utilities Act to introduce an obligation for CHP similar to that for renewables. The question is when should this be done.

  The present market conditions facing CHP, and most notably the New Electricity Trading Arrangements, are seriously undermining the economic viability of existing CHP plant and prospects for future investments. For renewable generators the availability of a supplier obligation (the Renewables Obligation, or RO) has provided some mitigation of the most severe effects of NETA. In the absence of this Obligation it is considered unlikely that investment in much new renewable generation would now be proceeding.

  CHP faces many of the same economic obstacles in the electricity market. In these circumstances it would be appropriate for Government to use the powers at its disposal to correct today's market imperfections by creating a similar market-based mechanism for CHP as for renewables.

  The RO is underpinned by a "buy-out" price that is imposed where percentage targets are not met. Any "buy-out" price under a CHP mechanism should properly be set at a lower rate than that under the RO, since the RO price was intended to reflect a number of objectives, including the need to stimulate investment in immature technologies. The level of the RO buy-out price has been increased to £30/MWh from the original level of £20/MWh. The Association understands that this increase was made in anticipation of difficult market conditions under NETA. Since these conditions apply equally to CHP, it would be appropriate to recognise this with a buy-out price that would probably need to be set at £10/MWh for CHP in today's market.


  The market conditions facing CHP today are acknowledged to be extremely difficult. Two recent studies, an EU-wide study of CHP supported by DEFRA[5] and work undertaken by Cambridge Econometrics[6], suggest that on current policies, UK CHP capacity will be in the range of 6.1 to 6.6 GWe by 2010. This indicates that the Government will miss its own target of 10 GWe of operating CHP capacity in 2010 by a margin of approximately 3.5 GWe. The environmental cost of this failure will be the missed opportunity to realise over three million tonnes of carbon savings per annum.

  The Association regrets that the weak and inconsistent application of the Government's commitment to sustainable development (and its CHP target) by both OFGEM and key parts of the DTI has, in large part, resulted in today's market conditions. This need not have been so.

  The Association welcomes the opportunity to present this submission to the Environmental Audit Committee.

January 2002

1   The views expressed in this paper cannot be taken to represent the views of all members of the CHPA. However, they do reflect a general consensus within the organisation. Back

2   Power UK, Issue 94, Platts, December 2001. Back

3   Penalties for Intermittent Sources of Energy, David Milborrow, December 2001. Back

4   Digest of UK Energy Statistics 2001, DTI, 2001. Back

5 Back

6   Combined Heat & Power to 2020: The Economic & Environmental Implications of Exploiting the Potential of CHP. November 2000. Back

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